Context: The Reserve Bank of India (RBI) asks banks to display information on borrowers linked to Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002.

What did the RBI do?

• The RBI has asked Regulated Entities (REs), to display information regarding borrowers whose secured assets have been taken into possession by the REs under the SARFAESI Act, 2002.

• REs: Commercial banks and Non-Banking Finance Companies (NBFCs).

• The first such list shall be displayed on the website of REs within 6 months from the date of this circular, and the list shall be updated on monthly basis.

• This step is part of RBI’s move towards greater transparency.

What is SARFAESI Act, 2002?

• The SARFAESI Act allows banks and other financial institutions for auctioning commercial or residential properties to recover a loan when a borrower fails to repay the loan amount.

• It enables banks to reduce their Non-Performing Assets (NPA) through recovery methods and reconstruction.

• NPA: Financial assets that are not generating income for the lender or borrower, typically due to delinquency or default on a loan.

• It provides that banks can seize the property of a borrower without going to court except for agricultural land.

• It is applicable only in the cases of secured loans where banks can enforce underlying securities such as hypothecation, mortgage, pledge etc.

• In the case of unsecured assets, the bank would have to go to court and file a civil case against the defaulters.

Objectives of SARFAESI Act, 2002

• Efficient/rapid recovery of Non-Performing Assets (NPAs) of the banks and FIs.

• Allows banks and financial institutions to auction properties (say, commercial/residential) when the borrower fails to repay their loans.

SARFAESI Act 2002: Applicability

Asset reconstruction company (ARC) registration

• ARC: A special type of financial institution that buys the debt of the bank at a mutually agreed value and attempts to recover the debts by itself.

Resolution of disputes

• Measures of asset reconstruction

• Acquisition of interest or rights in financial asset

How SARFAESI Act, 2002 works?

• The banks or financial institution issue notices to the defaulting borrowers to discharge their liabilities within 60 days period.

When the defaulting borrower fails to comply with the bank notice, then the SARFAESI Act gives for the following recourse to a bank:

• Take possession of the loan security

• Lease, sell or assign the right to the security

• Manage the same or appoint any person to manage the same

Methods of Recovery Under SARFAESI Act, 2002

Securitisation

• It is the process of issuing marketable securities backed by a pool of existing assets such as home or auto loans.

• An asset can be sold after it is converted into a marketable security.

• A securitization or ARC can help raise funds from only the Qualified Institutional Buyers (QIBs) by forming schemes for acquiring financial assets.

• QIBs: Institutional investors who possess expertise and the financial capacity to evaluate and invest in the capital markets.

Asset Reconstruction

• It can be done by managing the borrower’s business by selling or acquiring it or by rescheduling payments of debt payable by the borrower as per the provisions of the Act.

• Asset reconstruction empowers asset reconstruction companies.

Enforcement of security without the interruption of the court

• The Act empowers banks and financial institutions to issue notices to individuals who have obtained a secured asset from the borrower for paying the due amount and claim to a borrower’s debtor to pay the sum due to the borrower.

Issues with the Act

• One of the Act’s significant shortcomings is that it does not apply to unsecured creditors.

• Bank might acquire the asset if there was no better bidder but, if the asset is in an extremely remote place, it is of no use to the bank.

• The Act permitted the bank to keep a specific asset for a maximum of seven years. However, if the bank does not get a reasonable bid within the specified time frame, the remedy for such a situation is not specified in the Act.

Road Ahead

• Improve the fundamentals: Experts have consistently pointed to the need for improving the examination process during the initial stages of the lending process. 

• Usually the cause of bad loans has been traced to reckless lending undertaken by the banks to meet their lending targets.

• Firm steps required to address the crisis: Government emphasised ‘4R strategy’ needs to be implemented in letter and spirit,

• Recognition of NPAs, 

• Resolution of bad loans and recovery of value from the assets, 

• Recapitalisation of the banks by the government and

• Reforms in the banking sector.